An intuitive model
for the yield curve, based on the notion of value-at-risk, is presented.It leads to interest
rates that hedge against potential losses incurred from holding an underlying
risky security until maturity.This
result is also shown to tie in directly with the Capital Asset Pricing Model
via the Sharpe Ratio.The
conclusion here is that the normal yield curve can be characterised by a
constant Sharpe Ratio, non-dimensionalised with respect toÖT, where T is the bond maturity.

Among other features of the model are that it is able to explain,
qualitatively if not quantitatively, the existence of (1) a normal yield curve at times of “normal
economic growth”, (2) an inverted curve during periods of “high uncertainty”, “high interest
rates” or “low economic growth”, (3) a flat yield curve in more certain times and (4) a liquidity
trap when economic growth is expected to be negative.